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Fitch Affirms Starbucks at 'A/F1'; Outlook Stable
February 16, 2017 / 4:06 PM / 10 months ago

Fitch Affirms Starbucks at 'A/F1'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, February 16 (Fitch) Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of Starbucks Corporation (Starbucks; NASDAQ: SBUX) at 'A/F1'. The Rating Outlook is Stable. At Jan. 1, 2017 Starbucks had $3.2 billion of total debt. A full list of Starbucks' ratings is provided at the end of this release. Starbucks' ratings reflect its consistent sales and operating earnings growth, balanced financial strategy and market leadership in the global coffee market. Ratings recognize the recent slowing in comparable store sales (comps) but incorporate Starbucks' ability to maintain credit statistics in line with an 'A' rating and Fitch's view that performance will continue to outperform the broader restaurant industry. Fitch expects total adjusted debt/EBITDAR to be maintained around 2.0x, annual free cash flow (FCF - cash flow from operations less capex and dividends) to exceed $1 billion, and no change in financial strategy over the intermediate term. KEY RATING DRIVERS Comps Slow Slightly But Continue to Lead Industry Starbucks' consolidated comps rose 3% during the quarter ended Jan. 1, 2017, a modest slowdown from the 5% plus comp growth over the past six years. The slowdown was due to difficult 8% comparisons during the prior year comparable period, weak restaurant industry traffic, and in-store congestion at the pickup area due to stronger than expected mobile order and pay demand. Average ticket was up 4%, benefiting from positive mix due in part to increased food sales, but transactions declined 1%. Fitch believes transaction trends and comps can improve as the company more effectively staffs around peak transaction times. Starbucks has maintained a competitive advantage in the U.S. restaurant industry by strengthening its brand and connection with customers via innovation, its loyalty program, and by leading in digital. Food and beverage innovation such as the ultra-premium Starbucks Reserve coffees, additional varieties on its Cold Brew platform, and Sous Vide Egg Bites continue to add 1% to 2% to comps. The company has nearly 13 million active Starbucks Rewards members, up 16% from last year, and mobile payments represent approximately 27% of total transactions. Robust Operating Earnings Growth, Substantial Cash Flow Starbucks' reported revenue and operating income have grown at a 12% and approximately 20% CAGR since 2010 to $21.3 billion and $4.2 billion, respectively, in 2016 while cash flow from operations increased to $4.6 billion from $1.7 billion over the same period. Fitch expects revenue and operating earnings to grow at a high single-digit rate annually over the next 24 months due to low single digit comp growth, expansion, and effective management of coffee costs and general and administrative (G&A) expenses. Starbucks has locked in the price on about 80% of its coffee needs for 2017 with commodity cost being slightly favorable in the first half of the year and slightly unfavorable in the back half. Moreover, the company is effectively realizing supply chain savings and intends to limit core G&A expense growth to half the rate of revenue growth even while investing in store-level employee wages and benefits. At Jan. 1, 2017, the company had 25,734 stores for which 50% were company-operated and 50% were licensed. Approximately 61% of units were in the North America, 26% were in the China/Asia Pacific (CAP) region, 11% were in Europe, the Middle East, and Africa (EMEA), and the remainder were in other geographies. Starbucks has grown its store base at an 8% CAGR since 2013 and expects to expand 8% in 2017 by opening about 2,100 new units. Approximately 1,000 of these stores will be in the CAP region, 800 in the Americas, and 300 in EMEA. Starbucks five-year plan includes increasing its store base approximately 50% to about 37,000 stores by 2021. Roughly 50% of net new stores will be in China and the U.S. Fitch is concerned about store saturation in the U.S., but concerns are partially mitigated by the fact that unit volumes and store level profitability continue to increase. AUV for U.S. company operated stores was $1.6 million in 2016, up from just under $1 million in 2008, while store cash profit margin was a record 31% in 2016. Balanced Financial Strategy, Stable Leverage Starbucks has maintained a balanced financial strategy over the past several years. The company is investing in its business with capex averaging roughly 7% of sales annually since 2013 and returning an increasing amount of cash to shareholders via dividends and share repurchases while maintaining total adjusted debt/EBITDAR near 2.0x. Starbucks raised its targeted dividend pay out to earnings to 40% to 50% in 2016 from 35% to 45% previously, and net share repurchases have increased to $1.8 billion in 2016 from less than $500 million in 2013. Share buybacks have mainly been funded with FCF which totaled approximately $2 billion in 2016. However, Fitch anticipates modest incremental debt could be used to partially finance buybacks going forward as operating earnings grow and Starbucks continues to target leverage ratios consistent with an A rating. Strong Brand Equity, Competitive Strength Starbucks is a highly respected brand that is maintaining its market leadership in coffee, growing its food and beverage menu offerings, and successfully engaging with customers. Moreover, increased distribution within grocery, other retail outlets, and with higher end Reserve stores and Roasteries further strengthen Starbucks' brand equity while reinforcing its competitive strength. According to Nation's Restaurant News Top 100 2016 survey, Starbucks ranks No. 1 in the U.S. beverage-snack category with approximately 60% share and more than twice the sales of its largest competitor in the category. Howard Schultz, current CEO and Chairman who is the primary visionary for the company, joined Starbucks in 1982 after the company was founded in 1971. In April 2017, Kevin Johnson, president and chief operating officer, will become CEO while Mr. Shultz remains chairman and focuses on innovation, design, and development of Starbucks Reserve Roasteries around the world along with the company's social impact initiatives. Fitch does not expect a change in operating or financial strategy. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for Starbucks include: --Revenue grows at a high single-digit growth rate annually over the next 24 months driven by high-single digit net unit growth and low-single comp growth; --Operating EBIT, excluding income from equity investees, growth averages high single-digit over the next 24 months with operating EBIT margin being flat at 19.1% in 2017 and expanding towards 20% over time; --Annual FCF exceeds $1 billion or more annually; --Total adjusted debt-to-operating EBITDAR is sustained around 2.0x. RATING SENSITIVITIES A positive rating action in the near term is not anticipated. However, a public commitment to maintain total adjusted debt-to-operating EBITDAR in the mid-1.0x range and a continuation of strong operating trends could result in an upgrade. A negative rating action would be considered if total adjusted debt-to-operating EBITDAR is sustained above the 2.0x to 2.2x range due to a more aggressive financial strategy, meaningful deceleration in comp growth below Fitch's expectations, or material margin contraction. Materially lower than expected FCF could also contribute to a negative action. LIQUIDITY Starbucks had $3.7 billion of liquidity at Jan. 1, 2017 consisting of $2 billion of cash and $140 million of short-term investments along with availability under an undrawn $1.5 billion revolving credit facility expiring Nov. 6, 2020. Amounts outstanding under the company's $1 billion commercial paper (CP) program are backstopped by available commitments under the revolver. At Jan. 1, 2017, there was no CP outstanding. Starbucks' only maturity over the next three years is $350 million of 2% senior unsecured notes due Dec. 5, 2018. FULL LIST OF RATING ACTIONS Fitch has affirmed Starbucks' ratings as follows: --Long-term IDR at 'A'; --Bank credit facility at 'A'; --Senior Unsecured debt at 'A'; --Short-term IDR at 'F1'; --Commercial paper at 'F1'. The Rating Outlook is Stable. Contact: Primary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Fitch Ratings, Inc. 70 W. Madison St. Chicago, IL 60602 Secondary Analyst William Densmore Senior Director +1-212-368-3125 Committee Chairperson Michael Weaver Managing Director +1-312-368-3156 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity include: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation. --Fitch views operating leases as debt-like obligations, so capitalizes gross rent expense using a multiple of 8x for its total adjusted debt/EBITDAR calculation. 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